What is Liquidity Ratios?
Looking for Liquidity Ratio Assignment help? Liquidity Ratio refers to the ability of the firm to meet its current Liabilities. It is the ratio between the liquid assets and the liabilities of the Bank or other Institutions. Therefore , these ratios are also known as Solvency Ratios. Liquidity Ratios measure a company’s ability to pay debt obligations and its margin of safety through the calculation of metrics including the current ratio , quick ratio etc. These ratios are used to assess the short term Financial position of the concern.
Benefits of Liquidity Ratios
These ratios are most useful when they are used in comparative form. For example : Internal Analysis regarding liquidity ratios involves utilizing multiple accounting periods that are reported using the same accounting methods. Comparing previous time periods to current operations allows analysts to track changes in the business. Therefore, a higher liquidity ratio indicates that a company is more liquid and has better coverage of outstanding debts.
Short term trade payables of the firm are primarily interested in the liquidity ratios of the firm as they want to know how promptly the firm can meet its current liabilities. Liquidity is not only a measure of how much cash a business has. It is also a measure of how easy it will be for the companyto raise enough cash or convert assets into cash. Assets like Accounts Receivables , trading securities , and inventories are relatively easy for many companies to convert into cash in the short term.
Interpretation of Liquidity Ratios
The liquidity ratios are a result of dividing cash and other liquid assets by the short term borrowings and current liabilities. They show the number of times the short term debt obligations are covered by the cash and liquid assets. If the value is greater than 1 , it means the short term obligations are fully covered.
From the following information of R Corp Inc , calculate its liquid ratio.
Cash $480; Debtors $720; inventory $900; Bills payable $170; Creditors $200 Accrued expenses $450; Tax payable $430.
Liquid Assets = Cash + Debtors = $1200
Current Liabilities = 1250
Liquid ratio = 1200/1250 = 0.960:1
Types of Liquidity ratios
There are 7 types of Liquidity ratios. They are :
- Working Capital Ratios
- Working Capital
- Quick Ratios
- Cash Ratios
- Acid-test Ratio
- Net working capital
- Current Ratio
Importance of Cash Cycle in Liquidity Ratios
The concept of Cash Cycle is also important for better understanding of liquidity ratios. The cash continuously cycles through the operations of a company. The cash continuously cycles through the operations of a company. A company’s cash is usually tied up in the finished goods, the raw materials and trade debtors . It is not until the inventory is sold , sales invoice is raised and the debtor’s make payments that the company receives cash. The cash tied up in the cash cycle is known as working capital and liquidity ratios try to measure balance between current assets and current liabilities.
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